The CARES Act allowed traditional IRA owners who were adversely affected by the COVID-19 pandemic to take a tax-favored Coronavirus distribution of up to a combined limit of $100,000 from one or more of their traditional IRAs in 2020.
You can recontribute the Coronavirus Distribution (CVD) amount(s) back into one or more traditional IRAs within three years of the withdrawal date(s). You treat each withdrawal and later recontribution within the three-year window as a federal-income-tax-free IRA rollover transaction. That’s the tax advantage.
The non-tax advantage is that there are no restrictions on how you can use Coronavirus Distribution funds. You can use the money to pay bills, help out family, whatever – and recontribute the money any time within the three-year window.
Key point. The favorable tax treatment applies equally to CVDs taken from garden-variety traditional IRAs, SEP-IRAs, SIMPLE-IRAs, and employer retirement plans that allowed CVDs.
Unfortunately, you must put up with some potentially awkward interim tax consequences before you arrive at the tax-free-rollover-equivalent outcome. The interim tax consequences can diminish the cash-management advantages of the CVD deal, and they require filing amended returns to gain federal-income-tax-free treatment.
You always have the option of simply keeping all or part of your CVD money. You’ll just have taxable income from the CVD amount that you don’t recontribute.
Good news. No matter what you do with your Coronavirus Distribution, you won’t owe the dreaded 10 percent early withdrawal penalty tax that generally applies to traditional IRA withdrawals taken before age 59-1/2. CVDs are completely exempt from the penalty tax.
More good news. When you recontribute a CVD amount within the three-year window, it’s deemed to be a direct trustee-to-trustee transfer that’s exempt from the one-IRA-rollover-per-year limitation.
Bad news. According to IRS Notice 2020-50, beneficiaries of inherited IRAs can receive CVDs as long as:
• they are eligible individuals,
• they can follow the three-year ratable inclusion rule to report taxable income from CVDs, and
• their CVDs are exempt from the 10 percent early distribution penalty tax.
But only an IRA Coronavirus Distribution that is otherwise eligible for tax-free rollover treatment can be recontributed. Therefore, CVDs received by beneficiaries of inherited IRAs (other than the surviving spouse of the IRA owner) cannot be recontributed. So, no tax-free-rollover-equivalent deal for those folks. Sorry.
There are advantages but handling your IRA distribution properly can become complicated. And there are more nuances we haven’t been able to cover here. Contact the tax professionals at Emerald Financial to discuss your situation to make sure you make the right moves to handle your CVD on your taxes.
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